All in a day's work
The small trader sometimes seems like a candidate for the
endangered species list. The flood of institutional money combined
with increasingly competitive and volatile markets effectively has
squeezed out many smaller-scale speculators, leaving a perception
that few opportunities remain for the off-floor commodities trader
who does not have Paul Tudor Jones-size pockets.
Fortunately, this is not entirely true. While futures trading certainly is
not a game for the uninformed or under-financed, there still are
ways for the smaller or more conservative trader to participate in the markets.
One way is through day-trading. Although it has inherent qualities that attract naturally
cautious traders, day-trading is not reserved exclusively for the small fry. Many large
traders and money managers who handle millions of dollars are drawn to the "clean slate"
aspect of day-trading as well.
The upside The benefit of day-trading can be summed up with one word: control. The
name of the game in futures trading is risk control, and day-trading provides one of the
best methods for limiting market exposure by allowing you to sidestep two potential
obstacles: heavy margins and overnight risk.
Margin rates initially are set by exchanges. Clearing firms generally margin customers at a
rate in line with the exchange figures -- sometimes more, but never less, because the firms
themselves are margined by the exchange. (Rates range from less than $100 per contract
to more than $15,000 for contracts like the S&P 500.) If a market moves against a trader,
the clearing firm may issue a margin call, instructing the trader to deposit more margin
money into his account to cover potential losses.
However, if you only trade on an intraday basis, offsetting all positions by the close, you
will avoid expensive margins that might otherwise prevent you from trading. If you have
$7,500 in your trading account, you can theoretically buy and sell an S&P 500 contract
during one trading session and take your profit (or loss). If you wanted to hold an S&P
500 position over a number of days or weeks, you would have to have at least the
minimum margin requirement in your account at all times. If you didn't, you might have to
come up with more margin money immediately or risk having your position liquidated. It's
important to remember, though, that your system will ultimately dictate the capital you need
to trade responsibly; there's a direct correlation between available capital and the
probability of success.
Intraday trading also protects you from the adverse effects of events that occur while the
markets are closed, resulting in large gap openings. Although some electronic overnight
markets now exist, the 24-hour global trading village still is a long way from reality, and
you have no control over world events that may turn a market against you while you sleep,
whether it's a government affecting your currency position, a war affecting your oil position
or a monsoon affecting your rice position.
The catch The other half of the equation, as you might expect, is that day-trading limits
your options in other ways; it shuts certain doors while it opens others. The day-trader
must adjust profit objectives to the shortened time horizon.
Day-trading rarely will give you the big trade you've been waiting for your whole life, but
on the other hand, you might sleep better at night without having to worry about the market
opening 10 points against you in the morning. Every day starts with a clean slate. In
football terms, day-trading might be considered the grind-it-out ground game vs. the flashy
passing game. Ball control vs. big play. You give up throwing the bomb but at the same
time remove the chance of the devastating interception.
Laying the foundation Most technical analysis that can be applied to monthly, weekly or
daily data will work on an intraday scale, at least to an extent. Indicators that are too
noise-sensitive or have a tendency to lag might give a distorted view of a market and lack
practical applications.
It's also important not to trade in a vacuum: Don't treat each day as an independent entity;
look at the longer-term picture to determine if you're operating in a larger uptrend or
downtrend, etc., so you have a better idea of what to expect.
You also must focus on contracts with enough liquidity to get good fills and enough
volatility for decent size price moves. Thinly traded contracts with narrow ranges can be
exercises in futility and frustration (see "A trader's paradise,").
Opening bell One decision every day-trader has to make is whether or not to trade on
the opening. Many on- and off-floor day-traders establish positions on the opening for two
reasons. First, the open usually is a heavy volume period. Second, the open usually is one
of the most volatile periods, as the market seeks to establish a trend or stable price level.
The opening often will introduce a short-term trend that may either indicate the direction
for the day, or give a false signal, in which case the day-trader can "fade" the early trend,
that is, buy or sell against it in anticipation of a reversal.
Day-trader, author and system designer George Angell lectures on day-trading the S&P
500 and offers food for thought: One extreme of the day's range usually is contained in the
first 30 minutes of trading.
Mind the gap Every trader has heard something along the lines of "gaps were meant to be
filled." Like many old sayings, this one has more than a kernel of truth in it. Markets often
exhibit a strong tendency to fill price gaps. The gap functions like a magnet, drawing prices
back before they can take off again.
The market gaps lower on
the opening but soon rises to
fill the gap. Traders had the
opportunity to buy the
opening and sell as the
market rose to fill the gap,
or sell the gap and wait for
the downtrend to resume.
If you look at an intraday bar chart, you will notice
that on gap openings the market often trades away
from the gap for the first few minutes, then quickly
reverses and "fills" the gap. For example, a market
that gaps lower initially may trend downward,
leading everyone to believe that a downtrend is in
effect. After five minutes, however, the price shoots
to the upside, closes the gap and reverses again, trading lower on the day. This scenario
presents two options: You could buy the opening and then sell when the market rises back
to the gap; or sell as the price fills the gap, expecting the downtrend to resume (see "Filling
the gap," left). If the opening gap is not filled within five or 10 minutes, there is a strong
possibility the early trend may be the dominant trend of the day.
One advantage to trading the opening: If you hit the market correctly, you can take your
profits and go home early. If you're wrong, you still have the rest of the day to look for
trading opportunities. But the characteristics of the opening period (high volatility and
liquidity) that make it such a potentially lucrative time to trade also make it risky.
Unfortunately, day-traders do not have a surplus of time to design strategies and make
decisions -- the average exchange trading session lasts six hours.
The flip side of this coin is presented by John Hill Sr., a trader, CTA and publisher of
Futures Truth newsletter. He thinks the early morning gives too many "false signals" and
suggests waiting for the second or third hour of trading to put on positions because the
primary trend for the day often establishes itself at that time. This method allows a trader to
avoid the uncertainty of trading volatile openings.
Market profile Another popular technique for gaining insight into intra-day price action is
the Market Profile, a method designed by J. Peter Steidlmayer and developed in
cooperation with the Chicago Board of Trade. In "Profile of a market" (below), the letter
designation of each time bracket is placed next to every price that traded within that time
bracket. The resulting "profile" shows the distribution of prices over the trading day.
This day's profile exhibits the
common bell-shaped curve of
the "normal day" profile.
The value area represents
the range to which price
keeps returning.
The main idea behind Market Profile is that
market profiles have three basic variations: the
normal day profile, the trending day profile and the
non-trending day profile. The idealized normal day
profile forms the familiar bell-shaped curve, with
most of the trading falling in the fatter middle range
(the "value area"), with a smaller amount of activity
at the extremes of the day's range (70% of profiles
fall into this category). In the trending day, the
value area will appear at one end of the range. Non-trending days do not exhibit a
predominant value area.
When a trader sees a normal day profile forming, for example, he can sell when price
moves above the value area and buy when price dips below it. Market Profile is useful in
determining the perceived value of a market on a given day and gives the day-trader a
method to evaluate the trading landscape he is in.
Another idea is to look at inter-market relationships. Floor traders especially look at
tick-by-tick movements in cash and correlated markets, buying or selling when they feel
price is out of line with these barometers. The influence of each tick in the T-bonds on the
S&P 500 can be very strong on a short-term basis.
Risk control, money management principles and common-sense trading are just as
important for day-traders as they are for large-position traders. Take your losses, don't
average trades, don't add on to losers and don't overtrade. Just because you're a
day-trader doesn't mean you have to trade every day. Wait for good opportunities.
Tomorrow's another day.
Pivot profits
William Greenspan is a day-trader who practices what he preaches. In addition to trading,
he runs a day-trading strategy school called Commodity Traders Boot Camp Ltd. in
Chicago. One of his cardinal rules: "Make 10 points on a million trades -- not a million
points on 10 trades." One method he uses successfully is called the pivot technique.
The basic pivot approach involves trading with support and resistance levels derived from
the previous day's high, low and closing prices. The idea is to sell when price violates these
levels in a break and buy when price pushes through them on the upside. Here are the
formulas:
1. (H + L + C) / 3 = P
2. 2P - L = R1
3. 2P - H = S1
4. (P - S1) + R1 = R2
5. P - (R1 - S1) = S2
Where:
P = Pivot, H = High,
L = Low, C = Close
R1 = Resistance level
1
S1 = Support level 1
R2 = Resistance level
2
S2 = Support level 2
Because former resistance becomes future support and vice versa, these levels provide
key stop-loss levels. For example, if you sold when the market broke through support
level 1, you immediately would place your stop at or just above the support level 1 price.
If the market reverses, you're out quickly with a small loss. If price continues to drop, you
can follow the market with a trailing stop.
Pivot points
Although these levels sometimes will provide valid support
and resistance levels throughout a trading day, their
significance diminishes as they are repeatedly violated. The
first penetration is the most important.
You also can use the opening range prices and the weekly highs and lows as support and
resistance levels.
Mark Etzkorn is a Chicago-based financial writer, researcher and trader.This article
originally appeared in Futures' January 1995 issue. |
